India needs a calibrated policy framework to operate in an increasingly resource-scarce world
Once again the buzz is around commodities and their long-term outlook. Goldman Sachs has just raised its outlook on commodities and reaffirmed their long-term bullish thesis. Morgan Stanley and Macquarie have also raised their oil forecasts for 2011 and 2012 to $120 and $130, respectively. Jeremy Grantham of GMO has recently come out with a paper outlining the case for commodities to remain in a structural bull market. He feels that we are running out of all commodities, and the 100-year downtrend in real commodity prices has been conclusively broken. The fact that a 100-year, 70-per cent real decline in commodity prices till 2002 has been erased entirely since then indicates that we are now entering a new paradigm, far removed from the old downtrend.
Much of the bullish argument about commodities centres around China. China today consumes over 50 per cent of the world’s cement and iron ore, and between 43 and 50 per cent of steel, copper, nickel and zinc. The bulls will argue that China is still a poor country, with per capita GDP only 20 per cent that of the US. Even as China continues to grow at 8 or 9 per cent per annum, its demand for all commodities will keep compounding, to the point where supplies will remain strained.
The fallacy of this argument (at least for base metals) is that though China is a poor country, its per capita consumption of these metals is already higher than its developed peers. On a per capita basis, China already consumes 34 per cent more zinc, about as much copper and nickel and only 16 per cent less aluminium than the US (source: BCA). The per capita consumption of these metals has been stagnant in developed countries over the past few decades, reflecting the shift towards services in their industrial structure.
This implies that as China continues to grow, and more closely resemble the industrial structure of a developed economy, in the coming decades its per capita commodity demand will not be substantially different from what it is today.
The BCA has modelled out the annualised growth in base metal consumption that China will experience if its per capita consumption in 2030 converges with South Korea, another manufacturing powerhouse. Remember that Korea’s per capita consumption is three times the US’. These studies indicate that China’s copper consumption will grow at only 6 per cent per annum over the next 20 years, compared to the 15 per cent annualised growth over the past decade. This would mean a 30 per cent reduction in annual incremental demand in terms of copper tonnage. For aluminium, the last decade’s growth rate of 17 per cent drops to under 5 per cent — something similar has happened in the case of other metals.
This implies that for the prices of these commodities to remain at elevated levels, another growth driver – most likely India – will have to kick in. If India were to have a less commodity-intensive growth profile than China as it develops, it is unlikely that prices will sustain, given the supply coming on line. Therefore, it is India, not China, that will determine the future pricing trajectory of base metals in the coming years. The fact is the world cannot support another equivalent of China, and unless we want all commodity prices to spike, our growth model has to be a lot less commodity-intensive.
Unfortunately, the story for oil is far less sanguine. China consumes only about 10 per cent of world supply, roughly equal to its GDP share. As China continues to grow, adding more automobiles on the road, its current low per capita consumption will rise. A significant downward shift in the growth of Chinese demand for crude oil over the coming years is unlikely. On the other hand, Indian demand will accelerate. Oil consumption will, thus, peak within a decade. Globally, over 70 per cent of crude is used for transportation. Unless we move away from the internal combustion engine, we cannot overcome our addiction to crude oil.
The story for agricultural commodities also seems grim. Here, as Mr Grantham points out, the growth in crop yields per acre has dropped to about 1.2 per cent per annum, which is close to the growth rate of global population. Little new arable land is available, and as the poor consume more meat, the grain intensity of their diet triples. So, we have very little margin of safety.
India is quite vulnerable to global commodity prices. Our whole macro economic framework comes under pressure if commodity prices surge, with the current account, fiscal balance and inflation all under stress. While we cannot control global oil prices, our energy efficiency is pathetic and we need to reform the whole pricing mechanism. The economy has to be given appropriate price signals, reflecting the true scarcity of crude and our import dependence.
In agriculture, too, the whole supply chain has to be cleaned up so that producers receive true and remunerative market-based prices. We continue to have yields well below global averages for most crops except cotton (where Bt seed has made a difference). There is plenty of scope for technological inputs to lift yields and boost farm-level economics. The policy framework has to allow this to happen.
In other commodities like iron ore and coal, we have huge reserves, but again a very poor policy framework in place. We cannot afford to take nine or ten years to operationalise mines. The whole approach towards the allocation of mineral resources is opaque and open to abuse. The government has spent years trying to formalise a mining bill, but to no avail. We must be the only country in the world that despite having huge reserves of coal will need to import over 100 million tonnes over the coming 24 months, enriching the economies of Indonesia and Australia. This is because we are unable to get our policy co-ordination right.
For such a vulnerable economy, and one that on the margin will drive the prices of many commodities globally, we do not seem to have a holistic commodity security strategy in place. Our policy framework is inadequate to ensure full and effective utilisation of domestic resources, and we do not have the infrastructure or global assets to ensure uninterrupted access to critical raw materials. Unlike China, where the state is active in ensuring long-term access to key raw materials, we seem to have sub-contracted this to our private sector and hope for the best. Much work needs to be done across many areas.
The author is founder and CEO, Amansa Capital.
The views expressed are personal
